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Creditor’s pumped up priority brings down DOCA

Connections Total Fitness for the Family Pty Limited (Connections) operated a gym on premises owned by Selkirk Pastoral Co Pty Limited (Selkirk). The gym business ultimately failed and ceased trading when administrators were appointed on 4 October 2013. Connections’ assets were limited to some cash at bank and a $1.1m claim against Selkirk.

A Deed of Company Arrangement (DOCA) was proposed under which the administrators’ existing solicitors (Meehans) would be paid ahead of employee entitlements on the basis that Meehans would continue to pursue the $1.1 claim against Selkirk. Unsurprisingly, Selkirk voted against the DOCA, but the DOCA resolution passed with the support of a number of related party proxies.

Selkirk sought orders pursuant to s 600A of the Corporations Act 2001 (Cth) (Corporations Act) setting aside the DOCA resolution. A Court can set aside a DOCA resolution if it is contrary to the interests of creditors as a whole, or has unreasonably prejudiced particular creditors.

Decision

Brereton J set aside the DOCA resolution on the basis that the proposed DOCA had no benefit to creditors generally and in fact caused detriment by preferring Meehans.

His Honour noted that DOCAs must promote the purposes of Part 5.3A, but since the gym business no longer existed, the focus must necessarily be on whether the deed administration would result in a better return for the company’s creditors and members than if the company was placed into liquidation. The Court will also consider the comparative prejudice suffered by different groups of creditors.

In this case, the proposed DOCA provided considerable benefit to the directors, in putting an end to any potential insolvent trading claim and provided considerable benefit to Meehans. The DOCA provided little benefit and actually caused detriment to creditors, as their claims would be subordinated to Meehan’s claims and creditors would lose the benefit of potential insolvent trading claims.

Accordingly, his Honour set aside the DOCA resolution and ordered that Connections be wound up.

Comment

This decision cautions against proposing DOCAs that prefer certain creditors unless there is a clear benefit to creditors as a whole. It also reminds creditors that there are meaningful avenues of disputing an unfair DOCA, even after it has been executed.